Cameron Passmore CIM, FMA, FCSI

Portfolio Manager

Benjamin Felix MBA, CFA, CFP

Associate Portfolio Manager
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The TFSA Should Not Be Overlooked by Incorporated Individuals with Long Time Horizons

August 7, 2015 - 2 comments

When people have corporations it is common for them to retain all earnings in excess of their living expenses inside of their corporation to avoid paying personal tax. This seems logical. By leaving the money in the corporation there is more money to invest in the corporate investment account, and we know that about $50,000 of dividends can be taken out of a corporation nearly tax-free, making the idea of leaving everything in the corporation until it’s time to draw a conservative retirement income appear very attractive.

With the TFSA’s annual contribution room now sitting at $10,000 per year, we thought it was time to put this common logic to the test. Does it make sense for incorporated individuals to withdraw additional dividends in excess of their living expenses to contribute to the TFSA? To answer this question we modeled the total after-tax value of $1 of active small business corporation income in the personal hands of the individual. The individual can retain the $1 of excess earnings in the corporation, pay the 15.5% small business corporation tax, invest $0.845 in the corporate investment account, and eventually pay personal tax on the withdrawal of a dividend. Alternatively, they can pay small business corporation tax on the $1, take out a dividend (paying personal tax at 38.29%*), and invest $0.521 in the TFSA where there are no tax implications on an eventual withdrawal.

The results of the analysis are intuitive. While using  the TFSA involves taking a significant haircut upfront, all future growth will be tax-free. This means that the rate of growth in the TFSA will be higher than the after tax rate of growth of the corporate investment account. Given a long enough period of time, the TFSA will overcome its initial tax hit and surpass the after-tax value of the corporate investment account. The TFSA has no time restrictions, and can remain untouched to eventually pass to a beneficiary tax-free on the death of the individual – depending on the age and health of the owner, it can have a very, very long time horizon.

These issues are discussed in more detail, alongside similar analysis for the RRSP, in our recent whitepaper, A Taxing Decision.

Note that to maximize the $10,000 annual TFSA limit, the individual would need to start with $19,193.86 of excess earnings in the corporation.

*The examples discussed consider an individual with income between $150,000 and $220,000 in Ontario in 2015.

By: Ben Felix with 2 comments.
  08/06/2017 1:36:38 PM
Ben Felix
Sue yes this is still valid in 2017. The reason that this works is that the investments held in the TFSA will grow faster on an after-tax basis than the same investments held in the corporation. Even though you take an initial tax hit to get funds out of the corporation to make a TFSA contribution, the increased after-tax growth rate in the TFSA will more than make up for it given a long enough time horizon. This remains true even if you are taking dividends out at the highest marginal tax rate – you would just need to wait longer to break even in that case. It’s closer to $33,000 of ineligible dividends that can be taken out of a corporation in Ontario without any taxes owing. If you have any GRIP balance, you may be able to take out more without paying tax.
  06/06/2017 4:07:43 PM
Hi Ben,
Could you comment on whether this idea would still be valid to be considered in 2017. And could you clarify, what is the max. amount you could take out of your corp. in dividends (assuming no salary) to be tax free. is it 40K? I am trying to decide if it makes sense to take out an excess of dividends to contribute to my TFSA for next year with much more contribution room due to taking some out. This would require more than the 40K to do this given the personal expenses that this dividend draw is going towards. Lots of moving parts and it sure is an interesting idea but with the Feds making some further pending changes to corps. this year I am not sure what to still do and what remains valid in terms of this article from 2015. Thanks for any thoughts you have.

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